ArpitGarg's Weblog

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Detroit Bankruptcy: What it means?

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Detroit pitching for high profile bankruptcy evoked nostalgia, given that I was part of the investment bank, which was one of the high profile bankruptcies of the 21st Century. I have only read of the Russian default of the old, but seeing an entire city go bankrupt in our times, is entirely different.

Detroit is more significant as it was the boom baby, the once-mighty motor city and the pillar of American economy. The situation is also symbolic of declining manufacturing might of US (barring the Weaponry).

How does bankruptcy work for a city?
When a firm goes bankrupt, the assets are sold off and creditors paid off on basis of debt seniority. If Detroit goes bankrupt eventually, it may have to fire public employees. May have to sell off its properties, which includes government offices, public schools, parks and whatever city owns (not the private property). Legally speaking all of it might happen. But since it’s a city, with humanity and politics involved, it might not come down to this.

Newly appointed Emergency Manager of Detroit Kevyn Orr, has put together a plan to save the city. It can be read here. I have tried to summarize the plan and what holds for Detroit in the future.

How bad is the situation?
Population has declined from 1.8mil in 1950 to under 0.7mil in 2012, showing clear signs of decay. Unemployment rate has shot up from 7.3% in 2000 to 18.6% in 2012. Total number of employed people has gone down from around 350k in 2000 to 275k in 2012.

City tried by increasing taxes which resulted in businesses leaving and people migrating. Though tax %age got higher, the quantum of tax kept shrinking. To quote from the plan, “The City is currently levying all taxes at or near statutory maximum rates.”

Reduced security spending over last 10 years resulted in 40% job cuts in Detroit Police Dept. This has led to DPD’s response times getting extremely high. Crime rate has become highest in its population category. Add to this, ageing police cars and fire equipment.

Lack of maintenance has left 40% street lights non-working. Almost all public parks have been shut down (317 open parks around 5 years ago). Public transport has taken a beating due to unmaintained buses. Around 40,000 buildings have turned into dangerous structures sans repairs.

Estimated debt has ballooned to 18billion dollars. Citi has already deferred interest payments to creditors and contribution to pensioners. Bonds have no value anymore. Credit rating has plummeted from A in 2003 to CCC in 2012 (Courtesy Fitch Ratings)

Why is the need for bankruptcy?
It’s not exactly bankruptcy but protection from creditors till city restructures itself. In other words since Detroit does not have money to pay creditors and pensioners, it has to take some legal recourse to save itself from lawsuits demanding the same.

To quote from the plan, “The City cannot stabilize or pay creditors meaningful recoveries if it continues to shrink. Since the City will not generate sufficient cash to pay all liabilities, alternatives have to be considered. Need to reform the City government operations to improve efficiency and reduce costs.”

What’s in store post bankruptcy protection?
Well if City wants it can just deny paying its liabilities and no one can sue. It won’t be able to raise money by bonds and other resources as no one will be ready to lend. City will most surely increase Tax Rate forcing the remaining businesses to consider moving out of the city. It will further fire city employees to reduce operating costs, thereby shooting up unemployment rates.

How the future seems bleak is summarized by the following quote from the plan, “Where cost savings or service improvements can be achieved, the City will explore potential outsourcing of functions.”

For all I can say, its Gotham time for Detroit. Hope it finds its own Bruce Wayne.

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Written by arpitgarg

July 19, 2013 at 6:11 pm

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